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Wednesday, October 24, 2012

A Free-Market Case for Ending Too Big to Fail

In the Daily Caller, I explore a free-market argument for ending Too Big to Fail:

The impetus for ending TBTF would not be to punish Wall Street but to
restore it. In the current situation of opaque and indefinite
government support, no one knows who’s going to be the next Lehman
Brothers (a big bank that was allowed to fail). Some well-connected
players may feel free to gamble under the belief that Washington will
back them if those bets go bad, but one or more might be wrong in that
assumption: their lucky firm could be the one Washington decides is to
be the sacrificial lamb before bailing out other big banks. The
liquidation of that firm could wipe out the wealth of its shareholders
and also cause many traders to lose their jobs. If this bank had not
assumed that it would have government protections, however, it might
have acted more prudently. Fear of failure is one of the greatest
sharpeners of prudence in a capitalist marketplace; by putting the
safety net of government bailouts under certain banks, we at once
encourage them to be more reckless and to make less sound investments. This is a bad outcome from both a civic and an economic perspective.

Republicans would benefit
politically from ending TBTF. Such an enterprise would appeal to
popular dissatisfaction with the banking system. But there is an even
more pressing reason for trying to achieve this aim: ending Too Big to
Fail would be a defense of the free market. In 2008/2009, the banking
system came closer to being socialized than at any time since the Great
Depression. If we are interested in ensuring a market-oriented banking
system, we must apply the principles of the market to the banking
system.